Locating Growth Capital During A Banking Crisis

Posted on: April 25th, 2023

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Fast growing companies require a steady diet of growth capital to support investment and working capital. Unless properly capitalized, fast-scaling businesses can easily outstrip their cash liquidity and hit the wall with negative consequences. During expansionary periods when the economy is rosy, growth capital is available in many forms such as lines of credit, revenue-based finance, venture debt, growth equity and mezzanine-based debt. There is an overabundance of lenders and investors across the spectrum ready to address your capital needs.

When the economy stumbles as it is today, lenders increase their risk premium and decrease their risk appetite leading to rapid contraction in available growth capital credit. This is especially true for growth capital providers whose business models depend on low interest rates and low economic volatility. These types of lenders cannot absorb higher interest costs into their return models and end up lending to weaker credits with larger loan loss probabilities. Locating growth capital during a banking crisis requires market insight. Understanding the market cycle for each lending segment and lender in your search universe is key to successful growth capital location.

Each segment has a characteristic pattern of activity that provides clues as to how willing they are to lend. Banks usually go overboard and make too many loans when the economy is strong. They put out too much money too quickly and then must pull back. Non-bank asset-based lenders usually wait out the early innings of an expansion and enter later in the game when collateral values are higher. Mezzanine debt lenders are usually cycle agnostic and are more influenced by their fund timelines.

Within each segment, lenders can be further divided into older lenders and new lenders. Older lenders have portfolios of loans, some of which may be stressed. They are usually more focused on their portfolio problems than they are on booking new loans. Brand new lenders have no portfolio problems and are only looking to book new assets, which makes them an ideal target. While the market conditions may be challenging now, finding a new lender in the proper growth capital segment will ultimately lead to long-term funding success.

As the Fed decides to ease interest rates, middle market acquisition financing structures will benefit in a number of ways. The underlying values of middle market companies will increase leading to a higher enterprise value and lower loan to value ratios for existing portfolio companies of acquisition financing lenders.

The role of acquisition financing is infrequently elevated above a functional transactional one. When a business needs financing to acquire, they go to the market and source acquisition financing to supplement their equity investment to close the deal. Despite existing in many different forms, acquisition financing is rarely explained in terms of the value it brings to the acquirer.

Acquisition financing underwriting usually focuses on business and financial issues that underpin the stability of cash flow. Providers of acquisition financing usually validate the durability of a company’s competitive advantage and the depth of its resource base. Environmental issues are usually not a major part of the analysis in today’s service and technology-based economy.